What You Need to Know About D&O Insurance: Top Ten List
By Mark E. Miller, Esq.1,
Greenberg Traurig, Washington, D.C. Office
View or download the PDF version of this Alert.
The last several years have been difficult for companies purchasing D&O
insurance. Large year-to-year increases in premiums, few bidders, and hard-line
negotiating by insurance carriers has prevailed. Fortunately, all of this
may be changing for the better. It is not uncommon for companies that had
only one D&O insurer bid on an account last year to find themselves with
multiple carriers competing for their business this year. With multiple
bids, companies, directors, and officers find themselves in a difficult
predicament — how to evaluate the strengths and weaknesses of various quotes,
and how to use that knowledge to negotiate the best possible coverage.
"D&O insurance products are complex, containing
over one hundred variables each, and any one of these variables
can result in either a denial of coverage or a reduction in the
amount of money an insurance carrier will pay for defense or settlement
of a claim."
As many former officers and directors know only too well, a failure to
procure adequate D&O insurance coverage can result in significant personal
loss. Corporate indemnity, which directors and officers rely upon to pay
their defense lawyers in the event they are investigated by a federal agency
or sued personally, disappears with insolvency or bankruptcy of the corporation.
This may leave directors and officers with only one line of defense between
their personal assets and plaintiffs’ lawyers — their D&O insurance coverage.
In these situations, personal estates and livelihoods often hinge on insurance
policy language, and sometimes, on a single sentence or phrase buried within
a D&O insurance contract or endorsement.
D&O insurance products are complex, containing over one hundred variables
each, and any one of these variables can result in either a denial of coverage
or a reduction in the amount of money an insurance carrier will pay for
defense or settlement of a claim. Given the right convergence of unfortunate
circumstances, any one of these variables can directly impact the personal
assets of a director or officer. Following a general summary of D&O insurance
products, ten of the most important D&O insurance issues are addressed.
D&O Insurance Products
The basic D&O insurance product offered by most domestic and foreign
insurance carriers has at least two separate parts, an executive liability
part, often referred to as “Side A,” and a corporate reimbursement part,
often referred to as “Side B.” The Side A portion of this coverage pays
directors and officers directly for loss (including defense costs) when
corporate indemnification is unavailable. The Side B portion of coverage
pays the corporation for any money it has paid as indemnification to the
insured directors and officers.
Although properly negotiated traditional D&O coverage is the building
block of any D&O insurance program, such coverage presents certain unavoidable
risks, even when properly negotiated. First, coverage for the corporation
can exhaust available limits, leaving directors and officers without coverage.
Second, a bankruptcy court could determine that policy proceeds are assets
of the estate, and prohibit payment to the directors and officers under
the policies. And third, innocent directors could lose coverage because
of misrepresentations, illegality, or deliberate fraudulent conduct of corporate
New D&O insurance products address some of these issues. Side A-only
excess coverage cannot be exhausted by payments to the corporation and is
beyond the grasp of bankruptcy courts, since none of its proceeds are paid
to the corporation. Independent Director Liability (IDL) coverage is designed
to cover independent directors in situations where other coverage is unavailable
due to the adverse conduct of corporate insiders.
Unfortunately, unlike other types of business insurance, there is no
standard D&O insurance policy form for any of these D&O insurance products,
and there is significant variability in language contained in various D&O
insurance products. The immense impact that this variability can have on
the personal wealth of directors and officers is illustrated in the following
“top ten” list of D&O insurance issues.
1. Severability of the Application
Most directors and officers never see the D&O insurance policy application,
but it can, nonetheless, act in a manner more potent than any policy provision
or exclusion. If an application is filled out incorrectly, even if the mistake
was innocent, an insurance carrier may seek to rescind the policy, defeating
coverage for all officers and directors. The impact of rescission is quite
severe. If a policy has been rescinded, it no longer legally exists, and,
as such, cannot provide coverage to any directors or officers seeking coverage
under the policy. One way to address this rescission issue is with express
language outlining that fraud or inaccuracies in the application cannot
be imputed to innocent directors and officers who had no knowledge of the
erroneous or untrue facts contained therein.
2. Non-Rescindable Coverage
Appropriate application severability language does not, however, always
offer the desired level of protection. Even with proper severability language,
an insurer may withhold coverage while it investigates the knowledge of
each specific director and officer. Similarly, adequate severability language
may not minimize the chance of an insurance carrier filing a lawsuit against
the directors and officers seeking a judicial determination that sufficient
knowledge was known to justify rescission. One way to further minimize rescission
risks is to bind non-rescindable coverage, something not generally provided
in traditional D&O insurance contracts, but which is, nonetheless, obtainable.
To aid in the review of D&O insurance policies, Greenberg
Traurig’s Insurance Coverage Practice Group has developed a proprietary
“D&O Insurance Report Card,” which analyzes over one hundred D&O
insurance issues in an easy to understand manner, facilitating a
comparison of terms offered by competing insurance carriers.
3. Defense Allocation Provisions
Securities lawsuits commonly name a number of different parties and allege
a number of different causes of action. When some of the parties are covered
under the policy and others are not, or when some of the causes of action
are covered, and others are not, an insurance carrier may assert that it
does not have an obligation to pay for all of the defense costs incurred.
To address this issue, many policies contain defense allocation provisions,
but these provisions generally do not deal with the issue favorably. Some
specify a pre-determined percent of defense costs that will be deemed covered,
and others specify that an insurance carrier may withhold payment of defense
costs until an agreement is reached regarding how much of any given claim
is covered. The problem with either of these two approaches is that both
presume that less than one hundred percent of defense costs will be paid
by the insurance carrier. It is often advisable to avoid such provisions,
especially where they conflict with legal principles requiring an insurance
carrier to provide full defense in the absence of such a provision.
4. Duty to Advance Defense Costs
Another common problem with defense coverage contained in some D&O insurance
policies is that it does not specify when an insurance carrier must reimburse
the directors and officers for defense costs incurred. Without such a provision,
directors or officers may have to wait until the end of the underlying lawsuit
for their insurance carrier to reimburse them for any of the defense costs
previously incurred. Such a scenario could cause the director or officer
to have to pay for their own defense costs with the hope that their insurer
will eventually reimburse them for all of the costs incurred. Naturally,
the better practice is not to leave the timing of defense cost reimbursement
to chance, and to negotiate coverage that requires reimbursement within
a specific number of days.
In the very recent past, it was common for D&O insurance policies to
contain a co-insurance provision requiring the policyholder to pay, or co-insure,
some specific percent of defense costs and other losses incurred. The presence
of these provisions has proved devastating to some unsuspecting directors
and officers, and should not be accepted with respect to coverage provided
under Side A of the policy, which pays the directors and officers directly
in the event of insolvency of the company.
6. Conduct Exclusion Language
D&O policies routinely contain exclusions for criminal conduct, fraud,
and illegal profit or advantage taken by the directors or officers. These
exclusions can often be narrowed. One way to narrow the scope is to require
“final adjudication” language, which should obligate an insurance carrier
to reimburse defense costs until a judicial decree in the underlying lawsuit
establishes wrongful excluded conduct. Another way is to require that the
exclusions will not apply unless there was “in fact” wrongful conduct, which
minimizes the chance of an insurance carrier denying coverage based on unfounded
allegations contained in the underlying lawsuit. Finally, some insurers
have been willing to narrow the fraud exclusion by inserting the word “deliberate”
in front of the word fraud, which may provide broader coverage in the problematic
area of securities fraud litigation, which by its very nature, alleges some
level of fraud.
"Another issue that arises with conduct exclusions
is how the exclusions apply to innocent directors and officers."
7. Severability of Conduct Exclusions
Another issue that arises with conduct exclusions is how the exclusions
apply to innocent directors and officers. If one officer, for example, is
convicted of a crime, or is guilty of self-dealing, an insurance carrier
could argue that coverage is defeated for all officers and directors covered
under the policy, regardless of their own personal conduct. To prevent this
scenario, conduct exclusions should contain appropriate severability language
stating that conduct of any officer or director will not be imputed to any
other officer or director.
8. Bankruptcy and the Insured vs. Insured Exclusion
No single D&O exclusion has generated more case law than the so-called
Insured vs. Insured exclusion. The reasons for the exclusion are based on
two common concepts: first, there should be no coverage where an insured
sues itself, and second, D&O insurance should not insure the financial results
of a company. Common Insured vs. Insured language, however, may do more
than protect against these two perceived inequities. It may bar coverage
for lawsuits brought by trustees and creditors in bankruptcy. The right
to coverage for a lawsuit brought by a trustee in bankruptcy against a director
or officer may hinge on four words - whether the policy states that coverage
is barred for any claim “brought by or on behalf of an Insured Organization”
or just for any claim “brought by an Insured Organization.” Where possible,
the policyholder should not agree to the “or on behalf of” language. Another
option is to seek language that specifically accepts trustee claims from
the exclusion, or that expressly covers such claims so long as they are
brought independently and without the help of the Insured Organization.
9. Side A-Only Excess Insurance Drop-Down
Directors and officers considering the purchase Side A-only coverage
should also recognize that not all side A-only coverage is alike. Two general
types of Side A excess coverage exist: standard follow-form excess Side
A coverage, and excess umbrella Side A coverage, sometimes called Difference
in Condition (“DIC”) coverage. Under the former type of Side A coverage,
if the primary policy contains problematic language related to severability
of the application, severability of the exclusions, or adverse exclusions,
the excess follow-form Side A-only policies may not drop-down and pick up
coverage when the primary policies have failed. Excess umbrella Side A-only
DIC coverage, in contrast, is designed to be broader than primary coverage,
and should “drop-down” and function as primary insurance in situations where
the primary carrier has canceled or rescinded coverage, or where the corporation
has refused to indemnify the director or officer in question.
Like the D&O insurance application, most directors and officers never
see warranties executed by the company as part of the D&O insurance procurement
process. Nonetheless, these warranties, which are commonly used in D&O insurance
underwriting, especially where limits have been increased, have been upheld
by some courts as a way for insurance carriers to defeat coverage. For this
reason, warranties should not be signed until they have been thoroughly
evaluated for impact on coverage.
At a minimum, these “top ten” issues illustrate the severity of issues
presented, and the level of review that should be conducted prior to binding
D&O insurance coverage. A thorough understanding of issues faced and potential
solutions requires, at a minimum, sufficient knowledge of applicable D&O
insurance law, and an understanding of insurance products currently available.
As a starting point, a D&O coverage review should include a side-by side
comparison of coverages offered by the various competing insurers. This
review should be followed by the negotiation of enhancements to coverage
to minimize risk associated with unfavorable provisions contained in the
strongest competing bids.
Considering the risks at stake, and the difficulty of legal issues implicated
with D&O insurance coverage, it is not uncommon for directors and officers
to require that the corporation retain independent outside legal counsel
to conduct a thorough D&O insurance policy review, and assist with negotiating
ongoing D&O coverage. In these situations, it is important to prepare early,
insist on skilled D&O insurance brokers, and involve independent outside
counsel long before coverage is bound. The below “D&O Insurance Renewal
Timetable” provides some key deadlines that should be met, and action items
that should be performed, starting 120 days prior to the expiration of current
D&O insurance policies.
1 Mark E. Miller is a shareholder in the
Washington, D.C. office of Greenberg Traurig, LLP where he counsels clients
with the procurement of D&O insurance coverage and prosecutes coverage disputes
on behalf of policyholders. Mr. Miller is a recognized authority on insurance
coverage issues, having written and been quoted extensively by leading publications
including Business Insurance, The National Law Journal,
Forbes and others. He can be reached at (202) 331-3175, or by e-mail
© 2004 Greenberg Traurig
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This GT ALERT is issued for informational purposes only and is not intended
to be construed or used as general legal advice. Greenberg Traurig attorneys provide
practical, result-oriented strategies and solutions tailored to meet our clients’
individual legal needs.